Fed Likely To Target Interest-Rate Message

The Federal Reserve is widely expected to focus on interest rates Wednesday, using its July statement to clear up any confusion over when the central bank plans to start raising rates.

The Federal Open Market Committee, the 19-member board that sets most Fed policy, ends two days of meetings today and will release a statement at 2 p.m.

The Fed is not expected to announce any policy changes related to interest rates or its bond purchase program known as quantitative easing.

“At the end of the day, we’re still in a slow growth economy with high unemployment and low inflation. And with that backdrop the Fed has no reason to start scaling back the $85 billion in monthly bond purchases,” said Greg McBride, senior financial analyst at Bankrate.com.

After weeks of clarification on when and how the Fed will begin phasing out bond purchases, analysts believe Fed policy makers now want to make it clear to investors that the timing of bond purchase tapering is not connected to the timing for raising interest rates from their historic lows.

In other words, while the two policies are obviously related, they are not directly tied to one another in terms of how they will eventually be phased out.

The Fed statement today is likely to reiterate the central bank’s often-stated message of recent months that bond purchases will only begin to be phased out once economic data show that the program is no longer needed. Specifically, the Fed is looking for a stronger U.S. labor market.

Economists are predicting that the U.S. added 184,000 jobs in July, fewer than the 195,000 added in June but enough to reduce the unemployment rate to 7.5% from 7.6% in June. The Labor Department will release the July jobs report on Friday.

Meanwhile, a government report on Wednesday showed GDP expanded at a faster-than-expected 1.7% annual rate in the second quarter, but the figure for the first quarter was revised down to 1.1% from 1.8%.

Markets "Addicted to Stimulus"

Fed Chairman Ben Bernanke has said the unemployment rate is too high and overall workforce participation too low for the Fed to end its easy money policies any time soon.

The Fed is also concerned with deflation, which occurs when prices fall because demand is weak and can lead to a long-term stagnant economy. The inflation rate currently stands at about 1%, well below the Fed’s target rate of 2%.

Bernanke spooked markets last month when he suggested a hypothetical timeframe for when bond purchases might be tapered, suggested the process could begin as early as September and end by mid-2014. His comments sent stock markets plunging and bond yields surging.

Many investors mistakenly tied the phasing out of bond purchases to raising interest rates, which have sat near zero percent since December 20008. The thought was that if bond purchases were ending sooner rather than later, interest rates will be raised sooner rather than later as well.

Bernanke and his colleagues have spent the past six weeks vigorously attempting to clarify their message. And they will undoubtedly try again today in their statement.

“The market is addicted to Fed stimulus and investors shudder at the mere mention that eventually that stimulus is going to have to be scaled back,” said McBride.